Less than three years ago, all the Indian consumer internet unicorns had confidently asserted that that they were headed for an initial public offering (IPO).
I had challenged that very notion in my Founding Fuel piece The Narrow Exit Road for India’s Billion Dollar Startups. For a variety of reasons, I had said that the battle for domination of the Indian internet landscape would require a different set of hands on the poker table. Hands that held permanent capital and would not dither from taking a decade or longer view on our market.
Clearly, that moment has now arrived.
These players will hold the aces and would eventually buy our internet unicorns. Venture capitalists (VCs), who have a fiduciary responsibility to exit within a seven to nine year timeframe, would have to exit these companies to these strategics.
In short, the colour of money on the unicorn’s balance sheet will matter. And it would be a life and death issue.
The Chinese internet giants, specifically the trio of Baidu, Alibaba and Tencent (BAT), will move faster than the Western strategics—for the following reasons:
Reason #1: The Chinese have learnt their lessons back home in a context that is very different from the West. They implicitly know India is different—both from the West and their home ground as well. Give or take $30 billion, and they can buy out pretty much the second largest internet market in the world. Why build from scratch then?
Reason #2: The Chinese intimately understand the mobile-first ecosystem better than their Western counterparts. In any case, India is headed here too. So, it’s Advantage China again.
Reason #3: Quick wins by Amazon and Uber may have lulled the Americans into believing India is their market for the taking. In any case, an American stranglehold on the Indian consumer exists in the form of Facebook, WhatsApp, YouTube and Google.
The Chinese make no such assumptions. They are aware that given the cultural context and their management styles, operating businesses or even doing global market deals is fraught with risk. But India is a market where they can play to their strengths. And if they get in early, they can mould the ecosystem to their liking. They have the patience as well. Note how they waited until the frenzy of 2015 petered out last year.
Note: I club the Japan-based SoftBank, South Africa-based Naspers and other such permanent capital players with the Chinese. Both these firms have made their fortunes in backing the Chinese giants. For context, which is the stuff of legends—SoftBank managed to grow a tree worth $58 billion out of the $20 million it invested in Alibaba 14 years ago. In 2001, Naspers invested $32 million in Tencent. It is now worth $80 billion.
Why wouldn’t they want an encore? If it is possible any place in the world, it is in India. And who best to partner with than with BAT with whom they already have deep relationships built over the years. Put all of them together and they can have a huge influence on how consolidation will play out in this market.
Consolidation is inevitable
Why? Low ticket sizes, low frequency, unreliable supplies and the sheer cost of getting the “human element” of the chain to deliver consistently are pain points. Average transaction sizes are currently in the region of Rs 1,200-1,500 (about $25). With those kind of numbers, even with gross margins at 20-25%, the math doesn’t work.
The Indian customer has learned to become a bargain hunter as well. Weaned on a steady diet of “discounts”, this animal will take the best deal that comes its way. To that extent, the cost of retaining this creature is both unviable and expensive.
Despite huge cost rationalisation drives in 2016, firms will discover that they can’t escape the twin-pronged problem of poor economics and competing for the same customer. But now that several companies have achieved reasonable scale, combining them makes sense. That way, you create entities with larger market shares, which is the only way to break out of the spiral of poor unit economics.
That explains why conversations over the last one year inside the Indian entities are beginning to change. The innovation required to serve markets outside the well-heeled India One has now begun. (It ought to have started earlier. Not when funding has started to dry and VC investors need to exit.) Some have put in professionals to rescue operations. Others have shrunk their operations. But how do you shy away from competition? Whoever blinks now stares at a black hole in the form of falling market share. The Diwali frenzy in e-commerce was a pointer—it created a huge gap between the top two e-commerce players (Flipkart and Amazon) and the rest.
The consolidation game will play out in India, just like it did in China. But with a few differences:
1. Most Chinese companies had scaled to massive levels before they consolidated. They had become very large consumer franchises before their bloodied balance sheets forced them to merge. That is, the companies had achieved maturity as operating entities.
2. The consolidation is being done at a significantly different point in the lifecycle of the market. China’s internet penetration has hit 720 million and is set to slow down. In India we are still very early in the internet consumption story and have several years to mature.
It is not difficult to see why MakeMyTrip (MMT) and Ibibo merged—they were both bleeding between $80-90 million. Consumers and suppliers like hotels and airlines were the victors who took home the spoils of this online travel agency battle, even as both entities tried to discount their way into customer wallets. But consolidation has meant their survival is now not under constant threat. It has played virtually to script after China’s Ctrip purchased into the listed MMT in January 2016 as the lead shareholder. By October 2016, Ctrip paved the way for MMT to buy out Ibibo. The combined entity has three permanent capital hands—Naspers, Tencent and Baidu (via Ctrip)
Cut to the China story to look for parallels: Ctrip became a $10 billion giant after a fierce battle with Qunar, a $6 billion entity. It first wooed Qunar’s shareholder Baidu to sell Qunar. The Qunar team didn’t want the deal to go through—at least that is what has been reported. In any which case, the merger translated into a dominant online travel agency. Ctrip’s profits jumped ten-fold in a few months after the merger and both companies stopped haemorrhaging. Ctrip then went on to buy rival eLong for $671 million from Expedia.
There’s a good chance that similar outcomes could play out in every segment where players are large and differentiation is thin. Consolidation may be a natural value-creation mechanism. It will play out in classifieds (cars, peer-to-peer, rentals and home buying) and we can expect another round, possibly in travel, food-tech and logistics (hyperlocal and national).
How will it play out?
The Chinese players that are looking to buy into Indian internet companies know two things:
1. That the operations are not mature and hence, it’s best to stick to a minority position with a path to a significant stake or control. The complexity of the Indian market needs an Indian entrepreneur at the helm. Alibaba’s investment in Paytm is a good example of how Indian founders may continue to lead the venture, as long as the long-term interests of Alibaba—of gradually building the Alipay model of a financial services giant—is furthered. I firmly believe Chinese investments will be structured like the private venture capital arm of a corporation, as opposed to that of an operating owner. They have realised that going global is very different from becoming global.
2. They will aim to build an ecosystem. To build it, you don’t need a majority stake in any one entity. You’ve got to get comfortable with the idea of owning minority stakes in many entities and tie them together. Eventually, the thread that binds these properties delivers natural control. Tencent, Baidu and the other Chinese players have already begun making the moves, picking up small stakes in Hike Messenger, digital media firm Hungama and online healthcare service provider Practo. Several other deals are in the works, and we’ll hear of them soon.
In China, they’ve figured that while everyone in the world is playing on the economies of scale, or economies of scope—to battle the low average revenue per user (ARPU) and high friction structures, the weapon lies in creating economies of ecosystems—as they’ve done for the BAT companies. Each member of this trio has a network of properties that feed off each other.
They are comfortable holding cross-stakes in these large duopolies/monopolies. That’s how both Tencent and Baidu have stake in Ctrip. Didi, the taxi chain giant with over 85% market share, counts all three of the BAT trio as shareholders through a flurry of consolidation moves. What’s more, they’ve also managed to remove any threat from Uber, by coercing it to sell Uber China for a 17% stake.
WeChat is a prime example of that. WeChat developed the first ecosystem that deeply integrated transaction and social—and now its network spans multiple services where it has cross-holdings. Similarly, Alibaba is not running an e-commerce website—it has created an ecosystem of payments, marketplace and logistics that surrounds the consumer.
In India too, the Chinese will aim to slowly buy building blocks of the ecosystem that can rotate customers between their properties. I spoke about these flywheels in an earlier piece.
Editors Note: While this piece was being readied for publication, Alibaba announced a $200 million investment into Paytm’s e-commerce marketplace, paving the way for an Indian payments plus e-commerce ecosystem under the same brand.
Will this create monopolies?
In India, it makes no sense to draw the attention of the regulators or government. Plus, we are entering a phase of global protectionism and it will become a tool of state policy. India may follow suit. In any case, at some point India will have to deal with cyber security threats, especially if vital personal data of our citizens resides on the India Stack and payment platforms. In our typical style, security and privacy will get our attention only when we have the first misuse and breach. Sooner the better—since the damage potential will only go up in time.
Thus, from a strategic perspective, you’re better off to let a competitor survive, even if you have the muscle to snuff it out. Why invoke the wrath of the regulator?
So, it is entirely possible to imagine a future where Ola survives—or even thrives to some point; not because it can, but because Uber will allow it to, for its own good. That is one way the on-demand cab business could play out. Live and let live—and once you have the upper hand in market share, let the network effects play to create equilibrium.
The game: Beijing vs the Valley
The Chinese are clear: they will buy. The Americans will vacillate—their instinct will be to build—given the quick gains they’ve seen with Amazon and Uber. Remember they have talent on their side. There is no Silicon Valley giant without an Indian at the top rung of its management. Most have been dealing with India via their development centres for decades, there is no language barrier and they see that 90% of Indian internet traffic courses through vehicles they understand—Google, Facebook, YouTube and WhatsApp.
Google, Facebook and others will give an arm and a leg to build an ecosystem of the kind that BAT have built. It’s too late to do that in their home market in the US, and impossible in China. That leaves only India. The Americans must come. If Ctrip is here, why won’t the $83 billion gorilla Priceline want a piece of this market?
We may see some more flutters of excitement of the kind that Walmart or Paypal created with their sudden interest in entering the Indian e-commerce market. There are likely to be other global companies too who think they may be missing the bus in the largest accessible internet market in the world. And I think the recent “go digital” moves by the Indian government and Reliance Jio will propel this “we may get left out” feeling—and get their cheque books out sooner than later.
But it won’t play out like China
However, India cannot be China redux. This consolidation is happening too early. There are too many infrastructural bottlenecks. An untrained workforce creates issues in delivering consistent service. A challenger will constantly find a way to keep the bigger player under check, unless their pockets are deep and natural scale or network effects kick in.
For example, MMT still must build the market out and will stay in investment phase for a few more years until it is ready to contend with the entry of Priceline or Expedia. Only once that battle has played out can these players rest that the market has arrived at some steady state of competitive intensity.
Not just that. There is a fine line that separates a monopoly that is created and one that is granted. Chinese entities were granted monopoly status. In India, any entity must work hard to create dominance.
We will enter unchartered territory now—new players can create lean businesses on the highways that the early entrants built. An early example of that is Voonik, a challenger to Myntra in the fashion apparel space. It is gaining traction—and the fact that it has got to where it has possibly using about one-fifth the cash that Myntra did, augurs well for its future. Similarly, a new e-commerce marketplace can take off on the railroads that Flipkart, Snapdeal and Amazon have built.
All these players will have to look beyond the India One internet consumers of today, to the 500 million internet consumers whose incomes are rising and who will become accessible through Aadhaar and the India Stack.
There are two reasons why the focus will need to shift to these consumers.
One, demonetisation and the cashless India drive have caused a massive discontinuity—which will propel players to hunt for India Two and India Three consumers even faster.
To understand the second reason, let’s do some rough math:
- E-tailers expect revenues of about $14 billion from about 70 million online shoppers in 2017. That’s about $200 a pop a year. About a half of it is made up of smartphone sales, which contributes very little to margin or loyalty.
- They have invested over $10 billion so far to bring these shoppers online—and the bleed continues. Spend a few minutes with a calculator—put in a take rate (the commission a marketplace charges on the goods and services sold through its platform) of 6-8%, be generous in estimating overheads, and you will find that return on investment is beyond any discernible horizon. That’s how the cookie crumbles in the e-tailing world—profit comes from scale and dominant market share and you get nothing till you achieve that.
Just for comparison, China’s e-tailing market is roughly 60 times India’s today. China has 6X the number of online shoppers, and about 10X the annual spend per head.
India has a long way to go—even if we get more online shoppers, the average bill value is bound to plummet, since the new wave of consumers have very little capacity to spend. The shiny, new smartphones—that currently account for half of the online sales, and deliver easy gross merchandise value (GMV)—will have to give way to a basket of ultra low cost goods.
And so, when the served market expands from 70 million to 500 million customers, it will be like leaping off a precipice—average bill values will drop, customer acquisition will be expensive and firms will have to learn new tricks of the trade to deal with language, literacy and logistics barriers as they drive into the hinterland. Telcos of the scale of Vodafone and Idea have learnt those hard lessons: despite 200 million-plus subscribers, they struggle to turn a reasonable return and defensibility, because the ARPUs are just too low (they range between Rs 150 and Rs 200 a month).
By all indications, the second phase of the battle will be long-drawn and will require a different mindset.
Consider what the Chinese are up to. They have been in stealth mode, quietly penetrating our mobile market and building a connect with India Two and India Three consumers—something which the Westerners cannot see—with light browsers, data-saving apps, memory managers and app stores. Most of these services have quietly crept to near 100 million users, at the bottom of our internet pyramid.
These services have been tested in the Chinese market, the largest and most active home-grown mobile app market in the world. Android and iOS rule as the largest operating systems, but Chinese users don’t have access to Google Play or Apple Store. This allowed the ingenuity of the Chinese internet entrepreneurs to flourish without Western intervention—and they ended up creating thriving home-grown hardware and software systems. They are ready to customise these for Indian audiences, as they see similar needs at the bottom of our internet pyramid.
Meanwhile, to retain their first-mover advantage, there’s every chance that the Silicon Valley giants too are likely to step beyond their original playbook. In fact, India could be the first market where WhatsApp and Facebook Messenger attempt to take a leaf out of WeChat’s incredibly successful model in China.
The next disruption
While the desperate hunt for permanent capital is driving this current wave of consolidation—and bringing about a momentary truce in the capital warfare, the chances are that this phase may not last long.
That’s because there’s yet another discontinuity unfolding that will have profound implications on the entrepreneurial landscape. Falling data prices, cheaper smartphones, focus on regional languages, the advent of friction-less transactions (thanks to eKYC and Aadhaar), and the shift to a high trust society could spell a new wave of opportunities for a whole new generation of entrepreneurs. The vintage of 2017-2018 may turn out to be our best season for startups yet.
Thus, 2017 will only be a temporary respite—and the battle will continue as the market explodes into the next phase of growth. With a new set of hands around the table.
I end with a quote from Joseph Tussman, on the importance of aligning with general principles:
“What the pupil must learn, if he learns anything at all, is that the world will do most of the work for you, provided you co-operate with it by identifying how it really works and aligning with those realities. If we do not let the world teach us, it teaches us a lesson.”